Canada is benefiting from generally improved global conditions, but there are still plenty of risks external and internal that could derail the fragile recovery, the IMF warns in a new forecast.

The International Monetary Fund's spring global economic outlook predicts Canada economy will expand by 2.1 per cent this year and 2.2 per cent in 2013 — an upgrade from January's 1.7 and 2 per cent predictions.

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A trader talks on the phone during a Spanish Treasury bills auction at a private bank in Madrid, April 17, 2012. Spain's short-term borrowing costs jumped at a sale of more than 3 billion euros of short-term government debt on Tuesday, reflecting fears about the country's finances and boding ill for a key long-term debt auction later in the week. The Spanish Treasury sold 3.2 billion euros of 12 and 18-month bills, just above its target range of 2-3 billion in sales - solid demand from investors a day after the country's key 10-year bond yield hit a five-month high above 6 percent.
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Debt crisis

Asia

Although still moderate by historical standards, the expected growth rates puts Canada along with the U.S. in the top tier of the Group of Seven industrial nations.

The global economy, led by China, also was given a modest upgrade to 3.5 per cent this year and 4.1 per cent next.

“In Canada, the recovery is well advanced with room for policy-makers to respond flexibly to changes in the economic outlook, including by allowing full operation of automatic fiscal stabilizers and resorting to stimulus should the recovery threaten to falter,” the Washington-based economic organization states.

The 2012 forecast for Canada is now in line with the consensus of Canadian economists, although the IMF is still a little gloomier about 2013.

The fund sees unemployment remaining mostly unchanged in the next two years at 7.4 and 7.3 per cent respectively.

Still, the IMF report is full of dark foreboding about the risks and uncertainties darkening the outlook.

It sees Europe's debt crisis as far from settled, having the potential to spread contagion to other advanced economies, including the U.S. and indirectly Canada. As well, emerging economies might not perform as well as thought.

Meanwhile, there are heightened fears that political instability in the Middle East could result in a spike to oil prices, political gridlock in the Washington could tie the hands of policy-makers, and that emerging nations might underperform against expectations.

The IMF calls to the downside risks to the U.S. and Canada outlook “significant.”

“In Canada, the housing market is an area of potential vulnerability, with high house prices and rising household indebtedness,” it states.

“Strong spillovers to Canada from the United Sates mean it is also exposed to the risks” of a re-emergence of the European debt crisis, and a weaker recovery in the U.S..

The IMF's warning about household indebtedness — now at a near record 151 per cent of annual disposable income — echoes recent comments from Bank of Canada governor Mark Carney, who views it the top domestic vulnerability.

Earlier Tuesday, Mr. Carney kept the bank's target interest rate at one per cent although he has admitted such a low setting is encouraging some Canadians to borrow beyond what is wise. The alternative, however — hiking borrowing costs — risks damaging the economy by slowing down activity and boosting the loonie, analysts note.

While Mr. Carney has been reluctant to take his foot off the monetary accelerator, Finance Minister Jim Flaherty took the opposite tract on the fiscal side last month, introducing a budget that applies the brakes on spending and cuts 19,000 public service jobs.

At the moment, the IMF appears to agree with the fiscal restraint, but it adds as a caveat that should conditions deteriorate, “there is policy room” to reverse course.

The federal government is in position to resort to stimulus financing, the IMF says, given that its level of debt is well below that of other G7 countries.

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